PAPER – 2: STRATEGIC FINANCIAL MANAGEMENT

QUESTIONS
Security Valuation
1. Calculate the value of share from the following information:
Profit after tax of the company ` 290 crores
Equity capital of company ` 1,300 crores
Par value of share ` 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ` 47
Depreciation per share ` 39
Change in Working capital ` 3.45 per share
2. M/s Agfa Industries is planning to issue a debenture series on the following terms:
Face value ` 100
Term of maturity 10 years
Yearly coupon rate
Years
1−4 9%
5−8 10%
9 − 10 14%
The current market rate on similar debentures is 15 per cent per annum. The Company
proposes to price the issue in such a manner that it can yield 16 per cent compounded rate
of return to the investors. The Company also proposes to redeem the debentures at 5 per
cent premium on maturity. Determine the issue price of the debentures.
Portfolio Management
3. The distribution of return of security ‘F’ and the market portfolio ‘P’ is given below:
Probability Return %
F P
0.30 30 -10

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 34 FINAL (NEW) EXAMINATION: MAY, 2020

0.40 20 20
0.30 0 30
You are required to calculate the expected return of security ‘F’ and the market portfolio
‘P’, the covariance between the market portfolio and security and beta for the security.
4. A Portfolio Manager (PM) has the following four stocks in his portfolio:
Security No. of Shares Market Price per share (`) 
VSL 10,000 50 0.9
CSL 5,000 20 1.0
SML 8,000 25 1.5
APL 2,000 200 1.2
Compute the following:
(i) Portfolio beta.
(ii) If the PM seeks to reduce the beta to 0.8, how much risk free investment should he bring
in?
(iii) If the PM seeks to increase the beta to 1.2, how much risk free investment should he
bring in?
Mutual Fund
5. On 01-07-2016, Mr. X Invested ` 50,000/- at initial offer in Mutual Funds at a face value of
` 10 each per unit. On 31-03-2017, a dividend was paid @ 10% and annualized yield was
120%. On 31-03-2018, 20% dividend and capital gain of ` 0.60 per unit was given. Mr. X
redeemed all his 6271.98 units when his annualized yield was 71.50% over the period of
holding. Calculate NAV as on 31-03-2017, 31-03-2018 and 31-03-2019.
For calculations consider a year of 12 months.
Derivatives
6. From the following data for certain stock, find the value of a call option:
Price of stock now = ` 80
Exercise price = ` 75
Standard deviation of continuously compounded annual return = 0.40
Maturity period = 6 months
Annual interest rate = 12%

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 35

Given
Number of S.D. from Mean, (z) Area of the left or right (one tail)
0.25 0.4013
0.30 0.3821
0.55 0.2912
0.60 0.2743
e 0.12x0.5= 1.062
In 1.0667 = 0.0646
7. On January 1, 2018 an investor has a portfolio of 5 shares as given below:
Security Price No. of Shares Beta
A 349.30 5,000 1.15
B 480.50 7,000 0.40
C 593.52 8,000 0.90
D 734.70 10,000 0.95
E 824.85 2,000 0.85
The cost of capital to the investor is 10.5% per annum.
You are required to calculate:
(i) The beta of his portfolio.
(ii) The theoretical value of the NIFTY futures for February 2018.
(iii) The number of contracts of NIFTY the investor needs to sell to get a full hedge until
February for his portfolio if the current value of NIFTY is 5900 and NIFTY futures have
a minimum trade lot requirement of 200 units. Assume that the futures are trading at
their fair value.
(iv) The number of future contracts the investor should trade if he desires to reduce the
beta of his portfolios to 0.6.
No. of days in a year be treated as 365.
Given: In (1.105) = 0.0998 and e (0.015858) = 1.01598
Foreign Exchange Exposure and Risk Management
8. Followings are the spot exchange rates quoted at three different forex markets:
USD/INR 48.30 in Mumbai
GBP/INR 77.52 in London
GBP/USD 1.6231 in New York

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 36 FINAL (NEW) EXAMINATION: MAY, 2020

The arbitrageur has USD 1,00,00,000. Assuming that there are no transaction costs,
explain whether there is any arbitrage gain possible from the quoted spot exchange rates.
9. Nitrogen Ltd, a UK company is in the process of negotiating an order amounting to €4
million with a large German retailer on 6 months credit. If successful, this will be the first
time that Nitrogen Ltd has exported goods into the highly competitive German market. The
following three alternatives are being considered for managing the transaction risk before
the order is finalized.
(i) Invoice the German firm in Sterling using the current exchange rate to calculate the
invoice amount.
(ii) Alternative of invoicing the German firm in € and using a forward foreign exchange
contract to hedge the transaction risk.
(iii) Invoice the German first in € and use sufficient 6 months sterling future contracts (to
the nearly whole number) to hedge the transaction risk.
Following data is available:
Spot Rate € 1.1750 - €1.1770/£
6 months forward premium 0.55-0.60 Euro Cents
6 months future contract is currently trading at €1.1760/£
6 months future contract size is £62500
Spot rate and 6 months future rate €1.1785/£
Required:
(a) Calculate to the nearest £ the receipt for Nitrogen Ltd, under each of the three
proposals.
(b) In your opinion, which alternative would you consider to be the most appropriate and
the reason thereof.
International Financial Management
10. XYZ Ltd., a company based in India, manufactures very high quality modem furniture and
sells to a small number of retail outlets in India and Nepal. It is facing tough competition.
Recent studies on marketability of products have clearly indicated that the customer is now
more interested in variety and choice rather than exclusivity and exceptional quality. Since
the cost of quality wood in India is very high, the company is reviewing the proposal for
import of woods in bulk from Nepalese supplier.
The estimate of net Indian (`) and Nepalese Currency (NC) cash flows in Nominal terms
for this proposal is shown below:

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 37

Net Cash Flow (in millions)

Year 0 1 2 3
NC -25.000 2.600 3.800 4.100
Indian (`) 0 2.869 4.200 4.600
The following information is relevant:
(i) XYZ Ltd. evaluates all investments by using a discount rate of 9% p.a. All Nepalese
customers are invoiced in NC. NC cash flows are converted to Indian (`) at the
forward rate and discounted at the Indian rate.
(ii) Inflation rates in Nepal and India are expected to be 9% and 8% p.a. respectively.
The current exchange rate is ` 1= NC 1.6
Assuming that you are the finance manager of XYZ Ltd., calculate the net present value
(NPV) and modified internal rate of return (MIRR) of the proposal.
You may use following values with respect to discount factor for ` 1 @ 9%.
Present Value Future Value
Year 1 0.917 1.188
Year 2 0.842 1.090
Year 3 0.772 1
Interest Rate Risk Management
11. A Inc. and B Inc. intend to borrow $200,000 and $200,000 in ¥ respectively for a time
horizon of one year. The prevalent interest rates are as follows:
Company ¥ Loan $ Loan
A Inc 5% 9%
B Inc 8% 10%
The prevalent exchange rate is $1 = ¥120.
They entered in a currency swap under which it is agreed that B Inc will pay A Inc @ 1%
over the ¥ Loan interest rate which the later will have to pay as a result of the agreed
currency swap whereas A Inc will reimburse interest to B Inc only to the extent of 9%.
Keeping the exchange rate invariant, quantify the opportunity gain or loss component of
the ultimate outcome, resulting from the designed currency swap.
Corporate Valuation
12. ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They
want to know the value of the new strategy. Following information relating to the year which
has just ended, is available:

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 38 FINAL (NEW) EXAMINATION: MAY, 2020

Income Statement `
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years.
The gross margin ratio, Assets turnover ratio, the Capital structure and the income tax rate
will remain unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
Mergers, Acquisitions and Corporate Restructuring
13. The following information relating to the acquiring Company Abhiman Ltd. and the target
Company Abhishek Ltd. are available. Both the Companies are promoted by Multinational
Company, Trident Ltd. The promoter’s holding is 50% and 60% respectively in Abhiman
Ltd. and Abhishek Ltd.:
Abhiman Ltd. Abhishek Ltd.
Share Capital (`) 200 lakh 100 lakh
Free Reserve and Surplus (`) 800 lakh 500 lakh
Paid up Value per share (`) 100 10
Free float Market Capitalisation (`) 400 lakh 128 lakh
P/E Ratio (times) 10 4
Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the
swap ratio weights are assigned to different parameters by the Board of Directors as
follows:
Book Value 25%
EPS (Earning per share) 50%

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 39

Market Price 25%

(a) What is the swap ratio based on above weights?
(b) What is the Book Value, EPS and expected Market price of Abhiman Ltd. after
acquisition of Abhishek Ltd. (assuming P.E. ratio of Abhiman Ltd. remains unchanged
and all assets and liabilities of Abhishek Ltd. are taken over at book value).
(c) Calculate:
(i) Promoter’s revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
(iii) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.),
if after acquisition of Abhishek Ltd., Abhiman Ltd. decided to :
(a) Issue Bonus shares in the ratio of 1 : 2; and
(b) Split the stock (share) as ` 5 each fully paid.
Theoretical Questions
14. (a) How financial goals can be balanced vis-à-vis sustainable growth?
(b) What is Value at Risk? Identify its main features.
(c) Explain the factors affecting economic analysis.
15. (a) Discuss briefly the steps in securitization mechanism.
(b) What are some of the innovative ways to finance a start up?
(c) What is the difference between Management Buy Out and Leveraged Buyout? State
the purpose of a leveraged buyout with the help of an example.

SUGGESTED ANSWERS/HINTS

` 1,300crores
1. No. of Shares = = 32.5 Crores
` 40
PAT
EPS =
No.of shares
` 290 crores
EPS = = ` 8.923
32.5 crores
FCFE = Net income – [(1-b) (capex – dep) + (1-b) ( ΔWC )]
FCFE = 8.923 – [(1-0.27) (47-39) + (1-0.27) (3.45)]
= 8.923 – [5.84 + 2.5185] = 0.5645

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 40 FINAL (NEW) EXAMINATION: MAY, 2020

Cost of Equity = R f + ß (Rm – Rf)

= 8.7 + 0.1 (10.3 – 8.7) = 8.86%
FCFE(1+ g) 0.5645(1.08) 0.60966
Po = = = = ` 70.89
Ke − g 0.0886 − .08 0.0086

2. The issue price of the debentures will be the sum of present value of interest payments
during 10 years of its maturity and present value of redemption value of debenture.
Years Cash out flow (`) PVIF @ 16% PV
1 9 .862 7.758
2 9 .743 6.687
3 9 .641 5.769
4 9 .552 4.968
5 10 .476 4.76
6 10 .410 4.10
7 10 .354 3.54
8 10 .305 3.05
9 14 .263 3.682
10 14 + 105 = 119 .227 3.178 + 23.835
71.327
Thus the debentures should be priced at ` 71.327
3. Security F
Prob(P) Rf PxRf Deviations of F (Deviation) 2 (Deviations) 2
(Rf – ERf) of F PX
0.3 30 9 13 169 50.7
0.4 20 8 3 9 3.6
0.3 0 0 -17 289 86.7
ER f =17 Var f =141

STDEV  f = 141 = 11.87

Market Portfolio, P
RM PM Exp. Dev. of P (Dev. of (DeV.) 2 PM (Deviatio Dev. of F x
% Return (RM -ERM ) P) 2 n of F) x Dev. of P)
RM x PM (Deviatio x P
n of P)
-10 0.3 -3 -24 576 172.8 -312 -93.6

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 41

20 0.4 8 6 36 14.4 18 7.2

30 0.3 9 16 256 76.8 -272 -81.6
ERM =14 Var M =264 =Co Var P M
 M =16.25 =- 168
Co Var PM − 168
Beta= = = − .636
M2 264

4.
Security No. of Market Price (1) × (2) % to total (w) ß (x) wx
shares of Per Share
(1) (2)
VSL 10000 50 500000 0.4167 0.9 0.375
CSL 5000 20 100000 0.0833 1 0.083
SML 8000 25 200000 0.1667 1.5 0.250
APL 2000 200 400000 0.3333 1.2 0.400
1200000 1 1.108
Portfolio beta 1.108
(i) Required Beta 0.8
It should become (0.8 / 1.108) 72.2 % of present portfolio
If ` 12,00,000 is 72.20%, the total portfolio should be
` 12,00,000 × 100/72.20 or ` 16,62,050
Additional investment in zero risk should be (` 16,62,050 – ` 12,00,000) = ` 4,62,050
Revised Portfolio will be
Security No. of Market (1) × (2) % to ß (x) wx
shares Price of Per total (w)
(1) Share (2)
VSL 10000 50 500000 0.3008 0.9 0.271
CSL 5000 20 100000 0.0602 1 0.060
SML 8000 25 200000 0.1203 1.5 0.180
APL 2000 200 400000 0.2407 1.2 0.289
Risk free asset 46205 10 462050 0.2780 0 0
1662050 1 0.800

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 42 FINAL (NEW) EXAMINATION: MAY, 2020

(ii) To increase Beta to 1.2

Required beta 1.2
It should become 1.2 / 1.108 108.30% of present beta
If 1200000 is 108.30%, the total portfolio should be
1200000 × 100/108.30 or 1108033 say 1108030
Additional investment should be (-) 91967 i.e. Divest ` 91970 of Risk Free Asset
Revised Portfolio will be
Security No. of Market (1) × (2) % to ß (x) wx
shares Price of Per total (w)
(1) Share (2)
VSL 10000 50 500000 0.4513 0.9 0.406
CSL 5000 20 100000 0.0903 1 0.090
SML 8000 25 200000 0.1805 1.5 0.271
APL 2000 200 400000 0.3610 1.2 0.433
Risk free asset -9197 10 -91970 -0.0830 0 0
1108030 1 1.20
Portfolio beta 1.20
5. Yield for 9 months (120% x 9/12) = 90%
Market value of Investments as on 31.03.2017 = ` 50,000/- + (` 50,000x 90%)= ` 95,000/-
Therefore, NAV as on 31.03.2017 = (` 95,000 - ` 5,000)/5,000 = ` 18.00
` 5,000
Since dividend was reinvested by Mr. X, additional units acquired = = 277.78 unit
` 18
Therefore, units as on 31.03.2017 = 5,000 + 277.78 = 5,277.78
Alternatively, units as on 31.03.2017 = (` 95,000/`18) = 5,277.78
Dividend as on 31.03.2018 = 5,277.78 x ` 10 x 0.2 = `10,555.56
Capital Gain (5277.78 x ` 0.60) = ` 3,166.67
= `13,722.23
Let X be the NAV on 31.03.2018, then number of new units reinvested will be
`13,722.23/X.
Accordingly, 6,271.98 units shall consist of reinvested units and 5277.78 (as on
31.03.2017).

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 43

Thus, by way of equation it can be shown as follows:

` 13,722.23
6,271.98 = + 5,277.78
X
Therefore, NAV as on 31.03.2018 = ` 13,722.23/(6,271.98 – 5,277.78) = ` 13.80
NAV as on 31.03.2019 = ` 50,000 (1+0.715x33/12)/6,271.98 = `23.656
6. Applying the Black Scholes Formula,
Value of the Call option now:
The Formula C = SN(d1 ) − Ke( −rt) N(d2 )

In (S/K) + (r + 2 / 2)t
d1 =
 t
d2 = d1 - σ t

Where,
C = Theoretical call premium
S = Current stock price
t = time until option expiration
K = option striking price
r = risk-free interest rate
N = Cumulative standard normal distribution
e = exponential term
 = Standard deviation of continuously compounded annual return.
In = natural logarithim
In (1.0667) + (12% + 0.08)0.5
d1 =
0.40 0.5

= 0.0646 + (0.2)0.5
0.40  0.7071

0.1646
=
0.2828
= 0.5820
d2 = 0.5820 – 0.2828 = 0.2992

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 44 FINAL (NEW) EXAMINATION: MAY, 2020

N(d1) = N (0.5820)
N(d2) = N (0.2992)
Price = SN(d1 ) − Ke( −rt) N(d2 )

= 80 x N(d 1) – (75/1.062) x N(d 2)

Value of option
75
= 80 N(d 1) -  N(d2 )
1.062
N(d1) = N (0.5820) = 0.7197
N(d2) = N(0.2992) = 0.6176
75
Price = 80 x 0.7197 –  0.6176
1.062
= 57.57 – 70.62 x 0.6176
= 57.57 – 43.61
= `13.96
Teaching Notes:
Students may please note following important point:
Values of N(d 1) and N(d 2) have been computed by interpolating the values of areas under
respective numbers of SD from Mean (Z) given in the question.
It may also be possible that in question paper areas under Z may be mentioned otherwise
e.g. Cumulative Area or Area under Two tails. In such situation the areas of the respective
Zs given in the question will be as follows:
Cumulative Area
Number of S.D. from Mean, (z) Cumulative Area
0.25 0.5987
0.30 0.6179
0.55 0.7088
0.60 0.7257
Two tail area
Number of S.D. from Mean, (z) Area of the left and right (two tail)
0.25 0.8026
0.30 0.7642

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 45

0.55 0.5823
0.60 0.5485
7. (i) Calculation of Portfolio Beta
Security Price No. of Value Weightage Beta Weighted
of the shares wi Βi Beta
Stock
A 349.30 5,000 17,46,500 0.093 1.15 0.107
B 480.50 7,000 33,63,500 0.178 0.40 0.071
C 593.52 8,000 47,48,160 0.252 0.90 0.227
D 734.70 10,000 73,47,000 0.390 0.95 0.370
E 824.85 2,000 16,49,700 0.087 0.85 0.074
1,88,54,860 0.849
Portfolio Beta = 0.849
(ii) Calculation of Theoretical Value of Future Contract
Cost of Capital = 10.5% p.a. Accordingly, the Continuously Compounded Rate of
Interest ln (1.105) = 0.0998
For February 2013 contract, t= 58/365= 0.1589
Further F= Sert
F= ` 5,900e(0.0998)(0.1589)
F= ` 5,900e 0.015858
F= ` 5,900X1.01598 = ` 5,994.28
Alternatively, it can also be taken as follows:
0.105×58/365
= ` 5900 e
0.01668
= ` 5900 e
= ` 5900 x 1.01682 = ` 5,999.24
(iii) When total portfolio is to be hedged:
Value of Spot Position requiring hedging
 Portfolio Beta
= Value of Future Contract

1,88,54,860
=  0.849io= 13.35 contracts say 13 or 14 contracts
5994.28  200

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 46 FINAL (NEW) EXAMINATION: MAY, 2020

(iv) When total portfolio beta is to be reduced to 0.6:

P(P − β P' )
Number of Contracts to be sold = o
F
1,88,54,860 (0.849 - 0.600)
= io= 3.92 contracts say 4 contract
5994.28  200
8. The arbitrageur can proceed as stated below to realize arbitrage gains.
(i) Buy ` from USD 10,000,000 at Mumbai 48.30 × 10,000,000 = `483,000,000
` 483,000,000
(ii) Convert these ` to GBP at London ( ) = GBP 6,230,650.155
Rs. 77.52
(iii) Convert GBP to USD at New York GBP 6,230,650.155 × 1.6231 USD 10,112,968.26
There is net gain of USD 10,112968.26 less USD 10,000,000 i.e. USD 112,968.26
9. (i) Receipt under three proposals
(a) Invoicing in Sterling
€ 4 million
Invoicing in £ will produce = = £3398471
1.1770
(b) Use of Forward Contract
Forward Rate = €1.1770+0.0060 = 1.1830
€ 4 million
Using Forward Market hedge Sterling receipt would be = £ 3381234
1.1830
(c) Use of Future Contract
The equivalent sterling of the order placed based on future price (€1.1760)
€ 4.00 million
= = £ 3401360
1.1760
£3401360
Number of Contracts = = 54 Contracts (to the nearest whole number)
62,500
Thus, € amount hedged by future contract will be = 54  £62,500 = £3375000
Buy Future at €1.1760
Sell Future at €1.1785
€0.0025
Total profit on Future Contracts = 54  £62,500  €0.0025 = €8438

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 47

After 6 months
Amount Received €4000000
Add: Profit on Future Contracts € 8438
€ 4008438
Sterling Receipts
€ 4008438
On sale of € at spot = = €3401305
1.1785
(ii) Proposal of option (c) is preferable because the option (a) & (b) produces least
receipts.
10. Working Notes:
(i) Computation of Forward Rates
End of Year NC NC/`
1  (1 + 0.09 ) 
NC1.60 x 
 (1 + 0.08 )  1.615
 
2  (1 + 0.09 ) 
NC1.615 x 
 (1 + 0.08 )  1.630
 
3  (1 + 0.09 ) 
NC1.630 x 
 (1 + 0.08 )  1.645
 

(ii) NC Cash Flows converted in Indian Rupees

Year NC (Million) Conversion Rate ` (Million)
0 -25.00 1.600 -15.625
1 2.60 1.615 1.61
2 3.80 1.630 2.33
3 4.10 1.645 2.49
Net Present Value
(` Million)
Year Cash Flow in India Cash Flow in Nepal Total PVF PV
@ 9%
0 --- -15.625 -15.625 1.000 -15.625
1 2.869 1.61 4.479 0.917 4.107

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 48 FINAL (NEW) EXAMINATION: MAY, 2020

2 4.200 2.33 6.53 0.842 5.498

3 4.600 2.49 7.09 0.772 5.473
-0.547
Modified Internal Rate of Return
Year
0 1 2 3
Cash Flow (` Million) -15.625 4.479 6.53 7.09
Year 1 Cash Inflow reinvested for 2 years 5.32
(1.188 x 4.479)
Year 2 Cash Inflow reinvested for 1 years 7.12
(1.090 x 6.53)
19.53

TerminalCashFlow 19.53
MIRR = n −1= 3 − 1 = 0.0772 say 7.72%
InitialOutlay 15.625

11.
Opportunity gain of A Inc under currency Receipt Payment Net
swap
Interest to be remitted to B. Inc in
$ 2,00,000х9%=$18,000 ¥21,60,000
Converted into ($18,000 х ¥120)
Interest to be received from B. Inc in $ ¥14,40,000 -
converted into Y (6%х$2,00,000 х ¥120)
Interest payable on Y loan - ¥12,00,000
¥14,40,000 ¥33,60,000
Net Payment ¥19,20,000 -
¥33,60,000 ¥33,60,000
$ equivalent paid ¥19,20,000 х(1/¥120) $16,000
Interest payable without swap in $ $18,000
Opportunity gain in $ $ 2,000

Opportunity gain of B Inc under currency swap Receipt Payment Net

Interest to be remitted to A Inc in ($ 2,00,000 х 6%) $12,000

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Interest to be received from A. Inc in Y converted $18,000

into $ =¥21,60,000/¥120
Interest payable on $ loan@10% - $20,000
$18,000 $32,000
Net Payment $14,000 -
$32,000 $32,000
Y equivalent paid $14,000 X ¥120 ¥16,80,000
Interest payable without swap in ¥ ($2,00,000X¥120X8%) ¥19,20,000
Opportunity gain in Y ¥ 2,40,000
Alternative Solution
Cash Flows of A Inc
(i) At the time of exchange of principal amount
Transactions Cash Flows
Borrowings $2,00,000 x ¥120 + ¥240,00,000
Swap - ¥240,00,000
Swap +$2,00,000
Net Amount +$2,00,000
(ii) At the time of exchange of interest amount
Transactions Cash Flows
Interest to the lender ¥240,00,000X5% ¥12,00,000
Interest Receipt from B Inc. ¥2,00,000X120X6% ¥14,40,000
Net Saving (in $) ¥2,40,000/¥120 $2,000
Interest to B Inc. $2,00,000X9% -$18,000
Net Interest Cost -$16,000
A Inc. used $2,00,000 at the net cost of borrowing of $16,000 i.e. 8%. If it had not
opted for swap agreement the borrowing cost would have been 9%. Thus there is
saving of 1%.
Cash Flows of B Inc
(i) At the time of exchange of principal amount
Transactions Cash Flows
Borrowings + $2,00,000
Swap - $2,00,000

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 50 FINAL (NEW) EXAMINATION: MAY, 2020

Swap $2,00,000X¥120 +¥240,00,000

Net Amount +¥240,00,000
(ii) At the time of exchange of interest amount
Transactions Cash Flows
Interest to the lender $2,00,000X10% - $20,000
Interest Receipt from A Inc. +$18,000
Net Saving (in ¥) -$2,000X¥120 - ¥2,40,000
Interest to A Inc. $2,00,000X6%X¥120 - ¥14,40,000
Net Interest Cost - ¥16,80,000
B Inc. used ¥240,00,000 at the net cost of borrowing of ¥16,80,000 i.e. 7%. If it had
not opted for swap agreement the borrowing cost would have been 8%. Thus there is
saving of 1%.
12.
Projected Balance Sheet
Year 1 Year 2 Year 3 Year 4
Fixed Assets (40% of Sales) 9,600 11,520 13,824 13,824
Current Assets (20% of Sales) 4,800 5,760 6,912 6,912
Total Assets 14,400 17,280 20,736 20,736
Equity 14,400 17,280 20,736 20,736
Projected Cash Flows:-
Year 1 Year 2 Year 3 Year 4
Sales 24,000 28,800 34,560 34,560
PBT (10% of sale) 2,400 2,880 3,456 3,456
PAT (70%) 1,680 2,016 2,419.20 2,419.20
Depreciation 800 960 1,152 1,382
Addition to Fixed Assets 2,400 2,880 3,456 1,382
Increase in Current Assets 800 960 1,152 -
Operating cash flow (FCFF) (720) (864) (1,036.80) 2,419.20
Projected Cash Flows:-
Present value of Projected Cash Flows:-
Cash Flows PVF at 15% PV
-720 0.870 -626.40

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 51

-864 0.756 -653.18

-1,036.80 0.658 -682.21
-1,961.79
Residual Value - 2419.20/0.15 = 16,128
Present value of Residual value = 16128/(1.15) 3
= 16128/1.521 = 10603.55
Total shareholders’ value = 10,603.55 – 1,961.79 = 8,641.76
Pre strategy value = 1,400 / 0.15 = 9,333.33

 Value of strategy = 8,641.76 – 9,333.33 = – 691.57

Conclusion: The strategy is not financially viable.

13. (a) Swap Ratio
Abhiman Ltd. Abhishek Ltd.
Share Capital 200 Lakh 100 Lakh
Free Reserves 800 Lakh 500 Lakh
Total 1000 Lakh 600 Lakh
No. of Shares 2 Lakh 10 Lakh
Book Value per share ` 500 ` 60
Promoter’s holding 50% 60%
Non promoter’s holding 50% 40%
Free Float Market Cap. i.e. 400 Lakh 128 Lakh
relating to Public’s holding
Hence Total market Cap. 800 Lakh 320 Lakh
No. of Shares 2 Lakh 10 Lakh
Market Price ` 400 ` 32
P/E Ratio 10 4
EPS 40 8
Profits (` 2 X 40 lakh) ` 80 lakh -
(` 8 X 10 lakh) - ` 80 lakh
Calculation of Swap Ratio
Book Value 1 : 0.12 i.e. 0.12 x 25% 0.03

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 52 FINAL (NEW) EXAMINATION: MAY, 2020

EPS 1 : 0.2 0.20 x 50% 0.10

Market Price 1 : 0.08 0.08 x 25% 0.02
Total 0.15
Swap ratio is for every one share of Abhishek Ltd., to issue 0.15 shares of Abhiman
Ltd. Hence total no. of shares to be issued
= 10 Lakh x 0.15 = 1.50 lakh shares
(b) Book Value, EPS & Market Price
Total No of Shares 2 Lakh + 1.5 Lakh = 3.5 Lakh
Total Capital ` 200 Lakh + ` 150 Lakh = ` 350 Lakh
Reserves ` 800 Lakh + ` 450 Lakh = ` 1,250 Lakh
Book Value ` 350 Lakh + ` 1,250 Lakh = ` 457.14 per share
3.5 Lakh
Total Profit ` 80 Lakh +` 80 Lakh ` 160 Lakh
EPS = = = ` 45.71
No. of Share 3.5 Lakh 3.5
Expected Market Price EPS (` 45.71) x P/E Ratio (10) = ` 457.10
(c) (1) Promoter’s holding
Promoter’s Revised Abhiman 50% i.e. 1.00 Lakh shares
Holding Abhishek 60% i.e. 0.90 Lakh shares
Total 1.90 Lakh shares
Promoter’s % = 1.90/3.50 x 100 = 54.29%
(2) Free Float Market Capitalisation
Free Float Market = (3.5 Lakh – 1.9 Lakh) x ` 457.10
Capitalisation = ` 731.36 Lakh
(3) (i) & (ii)
Revised Capital ` 350 Lakh + ` 175 Lakh = ` 525 Lakh
No. of shares before Split (F.V ` 100) 5.25 Lakh
No. of Shares after Split (F.V. ` 5 ) 5.25 x 20 = 105 Lakh
EPS 160 Lakh / 105 Lakh = 1.523
Book Value Cap. ` 525 Lakh + ` 1075 Lakh
105 Lakh
= ` 15.238 per share

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 53

14. (a) The concept of sustainable growth can be helpful for planning healthy corporate
growth. This concept forces managers to consider the financial consequences of
sales increases and to set sales growth goals that are consistent with the operating
and financial policies of the firm. Often, a conflict can arise if growth objectives are
not consistent with the value of the organization's sustainable growth. Question
concerning right distribution of resources may take a difficult shape if we take into
consideration the rightness not for the current stakeholders but for the future
stakeholders also. To take an illustration, let us refer to fuel industry where resources
are limited in quantity and a judicial use of resources is needed to cater to the need
of the future customers along with the need of the present customers. One may have
noticed the save fuel campaign, a demarketing campaign that deviates from the usual
approach of sales growth strategy and preaches for conservation of fuel for their use
across generation. This is an example of stable growth strategy adopted by the oil
industry as a whole under resource constraints and the long run objective of survival
over years. Incremental growth strategy, profit strategy and pause strategy are other
variants of stable growth strategy.
Sustainable growth is important to enterprise long-term development. Too fast or too
slow growth will go against enterprise growth and development, so financial should
play important role in enterprise development, adopt suitable financial policy initiative
to make sure enterprise growth speed close to sustainable growth ratio and have
sustainable healthy development.
(b) VAR is a measure of risk of investment. Given the normal market condition in a set
of period, say, one day it estimates how much an investment might lose. This
investment can be a portfolio, capital investment or foreign exchange etc., VAR
answers two basic questions -
(i) What is worst case scenario?
(ii) What will be loss?
It was first applied in 1922 in New York Stock Exchange, entered the financial world
in 1990s and become world’s most widely used measure of financial risk.
Following are main features of VAR
(i) Components of Calculations: VAR calculation is based on following three
components:
(a) Time Period
(b) Confidence Level – Generally 95% and 99%
(c) Loss in percentage or in amount
(ii) Statistical Method: It is a type of statistical tool based on Standard Deviation.

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 54 FINAL (NEW) EXAMINATION: MAY, 2020

(iii) Time Horizon: VAR can be applied for different time horizons say one day, one
week, one month and so on.
(iv) Probability: Assuming the values are normally attributed, probability of maximum
loss can be predicted.
(v) Control Risk: Risk can be controlled by selling limits for maximum loss.
(vi) Z Score: Z Score indicates how many standard Deviations is away from Mean
value of a population. When it is multiplied with Standard Deviation it provides
VAR.
(c) Some of the factors affecting economic analysis are discussed as under:
(i) Growth Rates of National Income and Related Measures: For most purposes,
what is important is the difference between the nominal growth rate quoted by
GDP and the ‘real’ growth after taking inflation into account. The estimated
growth rate of the economy would be a pointer to the prospects for the industrial
sector, and therefore to the returns investors can expect from investment in
shares.
(ii) Growth Rates of Industrial Sector: This can be further broken down into
growth rates of various industries or groups of industries if required. The growth
rates in various industries are estimated based on the estimated demand for its
products.
(iii) Inflation: Inflation is measured in terms of either wholesale prices (the
Wholesale Price Index or WPI) or retail prices (Consumer Price Index or CPI).
The demand in some industries, particularly the consumer products industries,
is significantly influenced by the inflation rate. Therefore, firms in these
industries make continuous assessment about inflation rates likely to prevail in
the near future so as to fine-tune their pricing, distribution and promotion policies
to the anticipated impact of inflation on demand for their products.
(iv) Monsoon: Because of the strong forward and backward linkages, monsoon is
of great concern to investors in the stock market too.
15. (a) The various steps in securitization mechanism are discussed as below:
Creation of Pool of Assets
The process of securitization begins with creation of pool of assets by segregation of
assets backed by similar type of mortgages in terms of interest rate, risk, maturity and
concentration units.
Transfer to SPV
One assets have been pooled, they are transferred to Special Purpose Vehicle (SPV)
especially created for this purpose.

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 PAPER – 2 : STRATEGIC FINANCIAL MANAGEMENT 55

Sale of Securitized Papers

SPV designs the instruments based on nature of interest, risk, tenure etc. based on
pool of assets. These instruments can be Pass Through Security or Pay Through
Certificates, (discussed later).
Administration of assets
The administration of assets in subcontracted back to originator which collects
principal and interest from underlying assets and transfer it to SPV, which works as
a conduct.
Recourse to Originator
Performance of securitized papers depends on the performance of underlying assets
and unless specified in case of default they go back to originator from SPV.
Repayment of funds
SPV will repay the funds in form of interest and principal that arises from the assets
pooled.
Credit Rating to Instruments
Sometime before the sale of securitized instruments credit rating can be done to
assess the risk of the issuer.
(b) Some of the innovative steps to finance a startup are as follows:
(i) Personal financing. It may not seem to be innovative but you may be surprised
to note that most budding entrepreneurs never thought of saving any money to
start a business. This is important because most of the investors will not put
money into a deal if they see that you have not contributed any money from your
personal sources.
(ii) Personal credit lines. One qualifies for personal credit line based on one’s
personal credit efforts. Credit cards are a good example of this. However, banks
are very cautious while granting personal credit lines. They provide this facility
only when the business has enough cash flow to repay the line of credit.
(iii) Family and friends. These are the people who generally believe in you, without
even thinking that your idea works or not. However, the loan obligations to
friends and relatives should always be in writing as a promissory note or
otherwise.
(iv) Peer-to-peer lending. In this process group of people come together and lend
money to each other. Peer to peer to lending has been there for many years.
Many small and ethnic business groups having similar faith or interest generally
support each other in their start up endeavors.

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 56 FINAL (NEW) EXAMINATION: MAY, 2020

(v) Crowdfunding. Crowdfunding is the use of small amounts of capital from a large
number of individuals to finance a new business initiative. Crowdfunding makes
use of the easy accessibility of vast networks of people through social
media and crowdfunding websites to bring investors and entrepreneurs
together.
(vi) Microloans. Microloans are small loans that are given by individuals at a lower
interest to a new business ventures. These loans can be issued by a single
individual or aggregated across a number of individuals who each contribute a
portion of the total amount.
(vii) Vendor financing. Vendor financing is the form of financing in which a company
lends money to one of its customers so that he can buy products from the
company itself. Vendor financing also takes place when many manufacturers
and distributors are convinced to defer payment until the goods are sold. This
means extending the payment terms to a longer period for e.g. 30 days payment
period can be extended to 45 days or 60 days. However, this depends on one’s
credit worthiness and payment of more money.
(viii) Purchase order financing. The most common scaling problem faced by
startups is the inability to find a large new order. The reason is that t hey don’t
have the necessary cash to produce and deliver the product. Purchase order
financing companies often advance the required funds directly to the supplier.
This allows the transaction to complete and profit to flow up to the new business.
(ix) Factoring accounts receivables. In this method, a facility is given to the seller
who has sold the good on credit to fund his receivables till the amount is fully
received. So, when the goods are sold on credit, and the credit period (i.e. the
date upto which payment shall be made) is for example 6 months, factor will pay
most of the sold amount up front and rest of the amount later. Therefore, in this
way, a startup can meet his day to day expenses.
(c) The difference between Management Buy Outs and Leveraged Buy Outs has been
discussed as below:
Management Buy Outs
Buyouts initiated by the management team of a company are known as a
management buyout. In this type of acquisition, the company is bought by its own
management team.
MBOs are considered as a useful strategy for exiting those divisions that does not
form part of the core business of the entity.
Leveraged Buyout (LBO)
An acquisition of a company or a division of another company which is financed
entirely or partially (50% or more) using borrowed funds is termed as a leveraged

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buyout. The target company no longer remains public after the leveraged buyout;
hence the transaction is also known as going private. The deal is usually secured by
the acquired firm’s physical assets.
The intention behind an LBO transaction is to improve the operational efficiency of a
firm and increase the volume of its sales, thereby increasing the cash flow of the firm.
This extra cash flow generated will be used to pay back the debt in LBO transaction.
After an, LBO the target entity is managed by private investors, which makes it easier
to have a close control of its operational activities. The LBOs do not stay permanent.
Once the LBO is successful in increasing its profit margin and improving its
operational efficiency and the debt is paid back, it will go public again. Companies
that are in a leading market position with proven demand for product, have a strong
management team, strong relationships with key customers and suppliers and steady
growth are likely to become the target for LBOs. In India the first LBO took place in
the year 2000 when Tata Tea acquired Tetley in the United Kingdom. The deal value
was ` 2135 crores out of which almost 77% was financed by the company using debt.
The intention behind this deal was to get direct access to Tetley’s international
market. The largest LBO deal in terms of deal value (7.6 Billion) by an Indian company
is the buyout of Corus by Tata Steel.

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